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Question:

Which of the following statements about the component costs of capital is least accurate?

A The cost of preferred stock is the preferred dividend divided by the preferred ’s par value.
explanation

The cost of preferred stock is calculated as the preferred dividend divided by the market price, not the par value.

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Related Questions

Jay Construction Company is considering whether to accept a new bridge-building project. Jay will use the pure-play method to estimate the cost of capital for the project, using Cass Bridge Builders as a comparable company. To calculate the project beta, Jay should:

adjust Cass’s equity beta for any difference in leverage between Cass and Jay.

To use the pure-play method, an asset beta is calculated by removing the effects of leverage (delevering) from the comparable company’s equity beta, then a project beta is estimated by adjusting the asset beta (relevering) based on the capital structure of the company that is evaluating the project.

For a profitable company, issuing debt in order to retire common stock will most likely.

increase both the level and variability of return on equity.

An increase in debt will increase interest expense, which will decrease net income but not operating income, which is calculated before subtracting interest expense. For a profitable firm, the decrease in net income will be offset by the decrease in equity from the repurchase of common stock, so that ROE increases. The effect of the increase in financial leverage will, however, increase the variability of ROE for a given change in operating earnings.

The point of intersection between the marginal cost of capital and the investment opportunity schedule is known as the:

Optimal capital budget.

The optimal capital budget occurs at the point where the MCC schedule intersects the investment opportunity schedule.

Which of the following is least likely an important requirement of good corporate governance?

Members of the board should serve staggered, multiple-year terms.

There are benefits to both an annually elected board and a board with staggered multiple-year terms so neither can be considered a “requirement.” An annually elected board provides flexibility to nominate new board members in response to changes in the marketplace. Staggered boards may provide better continuity of board expertise and leadership but are more difficult to replace.

Project X has an internal rate of return (IRR) of 14%. Project Y has an IRR of 17%. Both projects have conventional cash flow patterns (all inflows after the initial cash outflow). If the required rate of return is:

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We know that at a 14% discount rate, the NPV of Project X is zero and the NPV of Project Y is greater than zero. There is no well-defined relationship between the required race of return and ordinary payback. If Project Y is smaller in size, its NPV may be smaller than that of Project X.

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For a board to be independent, it should not have a majority of members who are firm executives. Board members should not be closely aligned with customers, suppliers, or pension advisors since their interests may conflict with those of shareholders. The board should meet regularly outside the presence of management.

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8.45%.

Purchase price = 1,000 − [0.08 x (180 / 360) x 1,000] = $960
Bond equivalent yield = [(1,000 − 960) / 960] x 365 / 180 = 8.45%

Which of the following would most likely indicate deterioration of a firm’s working capital management?

An increase in days of receivables outstanding.

An increase in days of receivables outstanding, other things equal, will lengthen both the operating and cash conversion cycles, indicating poorer working capital management. An increase in days of payables outstanding, other things equal, would decrease the cash conversion cycle. A decrease in cash and marketable securities could simply indicate better management of cash (e.g., buying back its common stock or investing excess cash in profitable business opportunities or securities).

Business risk is best described as resulting from the combined effects of a firm’s:

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Business risk is the combination of sales risk, which is the variability of a firms sales, and operating risk, which is the additional variability in operating earnings (EBIT) caused by fixed operating costs.

All other factors remaining the same, which of the following statements is most likely regarding yields on short-term investments?

The discount basis yield will be lower than the money market yield.

• The discount basis yield will be lower than the money market yield, as it is based on the face value, not the price. Because the face value of a discounted instrument is greater than its price, the discount basis yield will be lower.
• The bond equivalent yield is greater than the money market yield because it is annualized over a 365‐day year, whereas the money market yield uses a 360‐day year.
• The discount basis yield can be greater than or less than the bond equivalent yield.

A company has been offered trade credit terms of “1/30 net 50.” What is the cost of trade credit for the company if it pays on the 40th day?

44.32%

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$500,000.

Capital component breakpoint = value at which component’s cost of capital changes / component’s weight WACC
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Which of the following is least likely one of the principles of capital budgeting?

Financing costs must be considered in the calculation of operating cash flows.

Financing costs should not be considered in the calculation of operating cash flows. Financing costs are considered in the discount rate (required rate of return).

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interest costs of a loan for the property purchase.

Financing costs should not be included in incremental cash flows. They are reflected in the weighted average cost of capital (WACC). New business at other branches is a positive externality and the $150,000 to sell the property is an opportunity cost.